Analysing Risks in Supply Networks To Facilitate Outsourcing Decisions

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International Journal of Production Research

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Analysing risks in supply networks to facilitate outsourcing decisions

Archie Lockamy III a;Kevin McCormack b
a
Brock School of Business, Samford University, Birmingham, Alabama, USA b College of
Management, North Carolina State University, Raleigh, North Carolina, USA
Online publication date: 10 December 2009
To cite this Article Lockamy III, Archie andMcCormack, Kevin(2010) 'Analysing risks in supply networks to facilitate
outsourcing decisions', International Journal of Production Research, 48: 2, 593 — 611
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International Journal of Production Research
Vol. 48, No. 2, 15 January 2010, 593–611
Analysing risks in supply networks to facilitate outsourcing decisions

Archie Lockamy IIIa* and Kevin McCormackb
a
Brock School of Business, Samford University, Birmingham, Alabama, USA;
b
College of Management, North Carolina State University, Raleigh, North Carolina, USA
(Revision received July 2009)
In an effort to achieve a competitive advantage via cost reductions and

improved market responsiveness, organisations are increasingly employing
Downloaded By: [North Carolina State University] At: 17:57 12 May 2010
outsourcing as a major component of their supply chain strategies. However,

as organisations increase their dependence on the suppliers of outsourced raw
materials and components, they become more susceptible to their risk profiles.
Supplier risk profiles are comprised of risk events which are associated with
the supply network, internal operations, or external factors. Suppliers with a
high probability of risk event occurrences can have a substantial impact on an
organisation’s revenue stream. Thus, it is essential that organisations have the
means to analyse the risks associated with a supplier of outsourced materials.
This article presents a methodology for analysing risks in supply networks to
facilitate outsourcing decisions. The methodology includes the development of
a risk profile for a given supplier through the creation of Bayesian networks.
The networks are used to analyse a supplier’s external, operational and
network risk probabilities, and the associated revenue impact on the
organisation. The methodology can be used by supply chain professionals to
facilitate outsourcing decisions with either current or prospective suppliers.
Keywords: outsourcing; supply networks; supply chain risks; risk events;
Bayesian networks
1. Introduction
Increased intensity in the management of global supply networks has resulted in the
adoption of outsourcing strategies by a growing number of organisations. The anticipated
benefits of outsourcing are to improve profitability and operating efficiency (Gonzalez
et al. 2005), reduce capital investment (Lynch 2004), improve business focus (Baldwin et al.
2001, Weerakkody et al. 2003), enhance flexibility (Jennings 2002, Lynch 2004), and to
gain a competitive advantage (Clott 2004). However, as an organisation’s dependency on
outsourced materials increases, it becomes more susceptible to the risk profiles associated
with their suppliers. Supplier risk profiles are comprised of risk events which are associated
with the supply network, internal operations, or external factors. Suppliers with a high
probability of risk event occurrences can have a substantial impact on an organisation’s
ability to generate revenue. Therefore, it is crucial that organisations have the capability to
analyse the risks associated with a supplier of outsourced materials.
*Corresponding author. Email: aalockam@samford.edu
ISSN 0020–7543 print/ISSN 1366–588X online

ß 2010 Taylor & Francis
DOI: 10.1080/00207540903175152
http://www.informaworld.com
594 A. Lockamy III and K. McCormack
1.1 Purpose
The purpose of this article is to present a methodology for analysing risks in supply
networks to facilitate outsourcing decisions. The methodology employs the use of
Bayesian networks for creating risk profiles of individual suppliers. The networks are used
to analyse a supplier’s external, operational and network risk probabilities, and the
associated revenue impact on the organisation. This methodology can be adopted by
supply chain managers to evaluate the level of risk associated with either current or
prospective suppliers, and to assist them in making outsourcing decisions.
1.2 Organisation
The paper is organised as follows. The first section provided the motivation for and
purpose of the paper. A discussion of supply chain management, outsourcing and supply
chain risks is provided in Section 2. Section 3 contains a description of the research
methodology used in this study. Section 4 contains the results of the research. Proposed
managerial actions based upon the results of the study are provided in Section 5. Finally,
conclusions and implications regarding study limitations and directions for future research
are presented in Section 6.
2. Supply chain management

A growing number of firms are adopting supply chain management (SCM) to improve
competitiveness (Singh et al. 2005, Li et al. 2006, Gunasekaran et al. 2008). SCM can be
characterised as a philosophy based upon the belief that each firm in the supply chain
directly and indirectly affects the performance of all the other supply chain members, as
well as ultimately, overall supply chain performance (Cooper et al. 1997). The effective use
of this philosophy requires that functional and supply chain partner activities are aligned
with company strategy and are congruent with organisational structure, processes, culture,
incentives and people (Abell 1999). Additionally, the chain-wide deployment of SCM
practices consistent with the above-mentioned philosophy is needed to accrue maximum
benefits to its members.
In order to realise the potential benefits of supply chain management, organisations are
required to make fundamental changes to their business focus (Kopczak and Johnson
2003). These changes include an emphasis on cross-functional and cross-enterprise
integration (Chen and Kang 2007); the effective management of the flow of physical goods
through suppliers, manufacturers, distributors and retailers for increased value to end
customers (Jammernegg and Reiner 2007); and the ability to acquire and manage reliable
demand information (Croxton et al. 2002). In addition, outsourcing has increasingly
become a key component of the SCM strategy for many firms. Factors leading firms
towards the adoption of outsourcing include the potential for reductions in cost and
capital investment, enhanced flexibility, and the ability to focus primarily on the firm’s
core competences (Lau and Zhang 2006).
2.1 Outsourcing
Outsourcing, generally defined as the shifting of work done ‘in-house’ to another
company, is thought of as a key strategy for improving cost and competitiveness
International Journal of Production Research 595
(Kremic et al. 2006). The outsourcing of logistics, IT and production has shifted the role of
many companies from a producer of goods to a coordinator of the industry value chain
(Choy and Lee 2003). This increase in supplier dependence has highlighted the need to
enhance the approaches to supplier management. Effective supplier selection, innovative
supplier development and meaningful supplier performance assessment have become key
competencies needed for success (Kannan and Tan 2002).
During the last decade, several events that impacted outsourced supply networks (i.e.,
earthquake in Kobe, Japan in 1995; terrorist attack on the World Trade Center in 2001;
Severe Acute Respiratory Syndrome (SARS) in 2002–2003) have significantly disrupted
supply chains and produced major losses for the lead companies involved (Tang 2006).
Companies such as Ericcson, Hershey, Apple, Wal-Mart, and a host of other major
companies who rely on timely delivery of products and services from outsourcing to meet
customer needs have incurred major losses due to supply chain disruptions. Publicly
traded firms experiencing supply chain disruptions, for example, have reported negative
stock market reactions to announcements of such disruptive events, with the magnitude of
the decline in market capitalisation being as large as 10% (Knight and Pretty 1996,
Hendricks and Singhal 2005). For example, Ericsson reported a $400 million loss because
it did not receive computer chip deliveries from a Philips plant in a timely manner (Latour
2001).
Although the true costs of any supply chain disruption can be difficult to
quantify precisely, at least one firm surveyed by Rice and Caniato (2003) estimated that
the daily cost impact of a disruption in its supply network to be in the neighbourhood of
$50–$100 million. These recent events have highlighted the need to add supply risk
management to the list of core competencies needed to manage an outsourced supply
network.
2.2 Supply chain risks

The risk of disruptions caused both from factors within supply chains (SCs) and from
outside environmental forces is of main concern to both practitioners and researchers.
Supply chain risk management (SCRM) is therefore a field of growing importance and is
aimed at developing approaches for the identification, assessment, analysis and treatment
of areas of vulnerability and risk in supply chains (Neiger et al. 2009). Various trends that
increase exposure to risks, such as the increased use of outsourcing, globalisation, supplier
base reductions, reduced inventory buffers, increased demand for on-time deliveries and
shorter product life cycles (Norrman and Jansson 2004) are elevating the importance of
SCRM. This is highlighted by several practical examples of the high costs of improper
preparation and response to various supply chain risk events cited by Chopra and Sodhi
(2004).
Currently, SCRM approaches are attempting to measure either supplier attributes or
supply chain structures to compare suppliers and predict disruptions. The results are then
used to prepare proper mitigation and response strategies associated with these suppliers.
Most often SCRM is a formal process that involves identifying potential losses,
understanding the likelihood of potential losses, and assigning significance to these
losses (Giunipero and Eltantawy 2004). A typical example of such an approach is the
PRAM (Procurement Risk Assessment and Mitigation) methodology, developed by
the Dow Chemical Company to measure SC risk and its impact. This approach examines
the following factors of a supply chain: supply market risk, supplier risk, organisation risk,
and supply strategy risk (Hackett Group 2007).
Due to the relative newness of the SCRM field, it is currently chaotic and somewhat
disorganised. Currently, there are several different classifications for risks, along with
assorted risk methodologies found in the literature. Often, only the disruptive events (such
as bankruptcy, natural disaster or the possibility of the terrorist attack) are included in the
classification schemes, while the softer factors between suppliers and customers (i.e.,
relationships, influence, leverage, information sharing, and cooperation) are ignored.
Risk is a concept that has applications in everything we do. It has several components,
not the least of which is the lack of knowledge about the events that may impact us and
our ability to manage them. In order to understand risk we first need to define and
decompose it, specifically as it pertains to the supply chain.
Risk in general can be defined as a collection of pairs of likelihood (L) and
outcomes (O):

Risk ¼ ðL1 , O1 Þ, ðL2 , O2 Þ, . . . , ðLn , On Þ ,
where Oi and Li denote outcome i and its related likelihood. The distribution pattern of
likelihood and outcome pairs is called a risk profile (Ayyub 2003). Definitions of risk must
also have a time dimension or a specific time horizon (i.e., day, month, year, etc.) and
a specific perspective or view that defines the unit of analysis (i.e., boundaries, etc.).
The International Organization for Standardization (ISO 2002) defines two of the
essential components of risk: losses (along with related amounts) and uncertainty of their
occurrence.
The research literature provides a number of approaches for defining risk in supply
networks. For example, supply chain risk can be divided, according to its source, in the
following manner: demand-side risks resulting from disruptions emerging from down-
stream supply chain operations (Suttner 2005); supply-side risks residing in purchasing,
supplier activities, and supplier relationships; and catastrophic risks that, when they
materialise, have a severe impact in terms of magnitude in the area of their occurrence
(Wagner and Bode 2006). Additionally, Treleven and Schweikhart (1988) have classified
risks into five categories, connected with disruption, price, inventories and schedule,
technology, and quality.
Zsidisin et al. (2005) defines supply risk as the probability of an incident associated
with inbound supply from individual supplier failures or the supply market occurring, in
which its outcomes result in the inability of the purchasing firm to meet customer demand
or cause threats to customer life and safety. Wu et al. (2006) states that inbound supply
risk is defined as the potential occurrence of an incident associated with inbound supply
from individual supplier failures or the supply market, resulting in the inability of the
purchasing firm to meet customer demand and as involving the potential occurrence of
events associated with inbound supply that can have significant detrimental effects on the
purchasing firm. Finally, Nagurney et al. (2005) defines demand side risk as represented by
the uncertainty surrounding the random demands which often occur at the retailer stage of
the supply chain.
Handfield and McCormack (2007) classify supply chain risks from the perspectives of
suppliers, customers, and the company. A supplier facing perspective examines the network
of suppliers, their markets, and their risk relationships with the ‘company’. A customer
facing perspective examines the network of customers and intermediaries, their markets,
and their risk relationships with the ‘company’. Finally, an internal facing perspective
examines risk relationships with respect to the company, its network of assets, processes,
products, systems and people, as well as its markets. The purpose of this study is to present
a methodology for analysing risks associated with suppliers of outsourced materials to
facilitate outsourcing decisions. Therefore, this research study uses the supplier facing
perspective in the analysis of supply chain risk. Additionally, this study further classifies
risk into three categories: operational, network, and external. In the financial industry,
operational risk is defined as the risk of loss resulting from inadequate or failed internal
processes, people and systems, or from external events (Basel Committee on Banking
Supervision 2006). Examples of operational risks are quality, delivery and service
problems. Network risk is defined as risk resulting from the structure of the supplier
network such as ownership, individual strategies of the suppliers, and the supplier’s supply
network agreements (Wu et al. 2006). External risks are defined as events driven by
external forces such as weather, earthquakes, political, regulatory and market forces
(Wagner and Bode 2006).
3. Research methodology
The research methodology for this study includes the use of surveys, the collection of data
from both internal and external company sources, and the development of Bayesian
networks used to create risk profiles for the study participants. A discussion on Bayesian
networks, the assessment model, the study participants, and data collection procedures are
provided in Sections 3.1, 3.2, and 3.3, respectively.
3.1 Bayesian networks

A Bayesian network is an annotated directed acyclic graph that encodes probabilistic
relationships among nodes of interest in an uncertain reasoning problem (Pai et al. 2003).
The representation describes these probabilistic relationships and includes a qualitative
structure that facilitates communication between a user and a system incorporating a
probabilistic model. Bayesian networks are based on the work of the mathematician and
theologian Rev. Thomas Bayes who worked with conditional probability theory in the late
1700s to discover a basic law of probability which came to be known as Bayes’ theorem.
Bayes’ theorem states that:
PðHjcÞ PðEjH,cÞ
PðHjE,cÞ ¼
PðEjcÞ
The posterior probability is given by the left-hand term of the equation, P(H|E,c).
It represents the probability of hypothesis H after considering the effect of evidence E on
past experience c. The term P(H|c) is the a-priori probability of H given c alone. Thus, the
a-priori probability can be viewed as the subjective belief of occurrence of hypothesis H
based upon past experience. The likelihood, represented by the term P(E|H,c), gives the
probability of the evidence assuming the hypothesis H and the background information c
is true. The term P(E|c) is independent of H and is regarded as a normalising or scaling
factor (Niedermayer 2003). Thus, Bayesian networks provide a methodology for
combining subjective beliefs with available evidence.
In recent years, Bayesian networks have evolved as a powerful tool to analyse

uncertainty (Pai et al. 2003, Cowell et al. 2007). When Bayesian networks were first
introduced, assigning the full probability distributions manually was time intensive.
Solving a Bayesian network with a considerable number of nodes is known to be a
nondeterministic polynomial time hard (NP hard) problem (Dagum and Luby 1993).
However, tremendous gains in computational power along with the development of
heuristic search techniques to find events with the highest probability have enhanced the
development and understanding of Bayesian networks. Correspondingly, the Bayesian
computational concept has become increasingly popular in such areas as medical diagnosis
and weapon tracking systems (Pai et al. 2003). The methodology has been shown to be
especially useful when information about past and/or current situations is vague,
incomplete, conflicting, and uncertain. A numerical example of a Bayesian network and
how it can be used to analyse uncertainty is presented in Appendix 1.
Pai et al. (2003) were among the first researchers to analyse supply chain risks using
Bayesian networks. The study examined the risk profile associated with a US Department
of Defense (DoD) supply chain for trinitrotoluene (TNT). The supply chain comprised
TNT recovery plants, storage facilities, and ammunition depots. Using Bayesian networks,
the researchers were able to establish risk factors and acceptable risk limits for all assets
contained in the DoD supply chain.
3.2 Assessment model

This study employs a risk assessment model used to evaluate the risks of each supplier
within the supply network. The model identifies and quantifies the risk of a supply
disruption using a framework that describes key supplier attributes, along with their
relationships and interactions with the company performing the assessment. The
framework consists of the following risk factors: relationship factors; supplier past
performance; human resources factors; history of supply chain disruptions; environmental
factors; disaster history; and, financial factors. The risk factors were developed based upon
the literature illustrating approaches to supply chain risks cited in Section 2.2.
Relationship factors include the level of influence, cooperation, power and shared
interests which exist within the network. Quality levels and on-time delivery history are key
factors in assessing risks based on past performance. Human resource factors include
employee relations issues, employee compensation as compared to industry norms, and
unionisation issues. The degree to which the supply chain has experienced disruptions is
a key factor in assessing risks based upon its history. Additionally, the history of disaster
events such as hurricanes, earthquakes, tornadoes, and floods are incorporated into the
framework. Finally, funding sources, debt levels, cash flow analysis, and other indicators
of financial health are utilised by the framework to assess financial risks. The risk
assessment model is illustrated in Figure 1.
The model uses a set of measures and scales that apply to each risk construct. The
measures were developed based upon key events which can directly impact a particular risk
factor. The measures and scales are used to create supplier risk profiles. The profiles reflect
the risk of a disruptive event involving a particular supplier. Supplier risk profiles are
expressed as numerical scores ascertained as a result of applying the model and measures.
The higher the risk profile score, the higher the disruption potential of the entity under
review. Appendix 2 contains the actual measures used in this study. In order to apply the
Interactions and
Relationships
Performance
S
Relationship
The customer’s reputation with

S suppliers is also a critical factor.
S
S SC
Network
Organiser
S
Supplier
Environment
Environmental S
Supplier
Attributes
Geographic, market,
transportation, etc. Human
Resources
S Supply Chain
Disruption
Financial
Health
Figure 1. Risk assessment model.
risk results to potential events, the survey results were reorganised into operational,
network and external risk-related measures, and the results were recalculated for each
supplier. The reorganised measures are presented in Appendix 3. The revenue impact
portion of the supplier risk profiles was calculated by: identifying the parts furnished by
the supplier; mapping the parts to a finished product and gross revenue for that product;
and, calculating the sum of associated monthly revenue for each supplier.
3.3 Sample and data collection

The data sample was a group of 15 automotive casting suppliers to a major automotive
company in the US. The data was collected using a four-step process. First, the suppliers’
representatives were interviewed to discuss the study and the supplier self-assessment
online survey instrument to be completed by the representatives. The survey instrument
links were then sent by email to the account representatives. Upon receiving the completed
surveys, the next step was to conduct on-site interviews with key personnel in the supply
chain departments to validate information collected via the survey instrument, and to
obtain more specific details on their supply chain risk factors. The third step in the data
collection process was to conduct interviews with commodity managers in the castings
area in an effort to triangulate the data collected from the surveys and supply chain
departments. Finally, off-site research was conducted to gather data regarding the
following: market dynamics; mergers, divestitures, and acquisitions; regulatory issues;
disasters; and transportation disruptions. This data was used to measure environmental
risk factors. A five-point Likert scale was used for the rating of all risk factors, and a risk
index was calculated for each supplier.
4. Results
Upon the collection of network, operational, and external risk data for each supplier,
Bayesian networks were constructed to establish their risk profiles using a supplier facing
perspective. Thus, the model examines the probability of a supplier’s revenue impact on
a company based upon the supplier’s associated network, operational, and external risks.
Network, operational, and external risks were determined based upon the a priori
probabilities for risk events which directly influence them, as outlined in Appendix 3.
These probabilities were ascertained via the data collection process. An illustration of the
Bayesian network for Supplier 1 is provided in Figure 2.
The variables in the Bayesian network are represented by nodes. Each node contains
states, or a set of probable values for each variable. The variables in the network illustrated
1 2 3 4 5 6 7 8 9 10 11 12
Network Operational External

Risks Risks Risks
Supplier
Revenue
Impact
Figure 2. Bayesian network for Supplier 1. Note: network key: 1 ¼ misalignment of interest;
2 ¼ supplier financial stress; 3 ¼ supplier leadership change; 4 ¼ tier 2 stoppage; 5 ¼ supplier network
misalignment; 6 ¼ quality problems; 7 ¼ delivery problems; 8 ¼ service problems; 9 ¼ supplier HR
problems; 10 ¼ supplier locked; 11 ¼ merger/divestiture; 12 ¼ disasters.
in Figure 2 can exist at two states (yes or no). Nodes are connected to show causality with an
arrow (known as an edge) indicating the direction of influence. When two nodes are joined
by an edge, the causal node is referred to as the parent of the influenced (child) node. Child
nodes are conditionally dependent upon their parent nodes. Thus, in Figure 2, the
probability of Supplier 1 experiencing network risks is dependent on the a priori probabilities
associated with the following variables: misalignment of interest; supplier financial stress;
supplier leadership change; tier 2 stoppage; and supplier network misalignment. The a priori
probabilities associated with the variables quality problems, delivery problems, and service
problems directly influence operational risks. Finally, external risks are dependent upon the
following variables: supplier HR problems, supplier locked (i.e., company cannot easily
switch to another supplier), merger/divestitures, and disasters. The joint probabilities of the
computed network, operational, and external risks are then used to determine the
probability that a supplier will have an adverse impact on the company’s revenue stream.
The product of the supplier’s revenue impact probability times its revenue impact is known
as value at risks. Value-at-risk (VAR) is widely used by banks, securities firms, commodity
merchants, energy merchants, and other trading organisations. Such firms track their
portfolios’ market risk by using historical volatility as a risk metric. VAR can also be used to
evaluate and manage risks in the supply chain. The Supply Chain Council defines VAR as
the sum of the probability of events times the monetary impact of the events for the specific
process, supplier, product or customer (SCOR Model 9.0 2008). Thus, this metric allows for
comparisons between suppliers to facilitate decisions regarding supply chain risk. This
research study examines monthly value-at-risk dollars for the company based upon the risk
profiles of each supplier.
The a priori probabilities for the 12 supply chain risk events which influence
network, operational, and external risks are presented in Table 1 for each supplier. These
values were used to generate a risk profile using Bayesian networks comprising network,
operational and external risk probabilities along with the supplier’s probability of revenue
impact on the company. The supplier risk profiles are displayed in Table 2. The table reveals
that Suppliers 1, 10 and 14 have the highest probability of revenue impact on the company,
while Supplier 11 has the lowest probability of revenue impact. Computations illustrating
the development of the risk profile for Supplier 1 are presented in Appendix 4.
4.1 Sensitivity analysis

A risk profile sensitivity analysis was conducted for each supplier to determine the effects
of known risk events (i.e., network, operational, and/or external risk have a 100%
probability of occurrence) on company revenues. An example of the analysis is illustrated
for Supplier 1 in Table 3. The table shows that the simultaneous occurrence of risk events
which result in network and external risks increases the probability of revenue impact from
the base case of 41% to 83%. A comparison of the supplier risk profiles based upon a
priori risk event probabilities and worst-case combinations of network, operational, and
external risks (excluding the scenario where all three risks have a 100% probability of
occurrence) along with corresponding value-at-risk results is provided in Table 4.
An examination of Table 4 reveals that the risk profile associated with Supplier 6
results in the largest value-at-risk dollars for both the base case ($148.80 million) and the
worst-case risks combination ($376.65 million). The risk profile of Supplier 15 yields the
smallest value-at-risk dollars for the base case ($2.13 million) and the worst-case risks
combination ($5.74 million). The largest percentage increase in value-at-risk dollars
602
Table 1. A priori probabilities for risk event variables.
Supplier Supplier Supplier

Misalignment financial leadership Tier 2 network Quality Delivery Service Supplier HR Supplier Merger/
Supplier of interest stress change stoppage misalignment problems problems problems problems locked divestiture Disasters
1 0.20 0.50 0.50 0.31 0.20 0.46 1.00 0.20 0.20 0.18 1.00 0.11
2 0.17 0.23 0.23 0.13 0.20 0.23 0.46 0.10 0.12 0.06 1.00 0.08
3 0.20 0.50 0.50 0.31 0.12 0.48 0.95 0.20 0.20 0.18 1.00 0.12
4 0.16 0.33 0.23 0.16 0.17 0.21 0.52 0.11 0.09 0.09 1.00 0.10
5 0.19 0.38 0.23 0.17 0.20 0.22 0.53 0.10 0.07 0.11 1.00 0.13
6 0.14 0.46 0.27 0.18 0.14 0.33 0.65 0.09 0.13 0.15 1.00 0.13
7 0.16 0.31 0.37 0.15 0.16 0.26 0.57 0.08 0.11 0.11 1.00 0.10
8 0.19 0.30 0.23 0.16 0.20 0.29 0.60 0.10 0.07 0.13 1.00 0.12
9 0.15 0.35 0.27 0.15 0.17 0.30 0.63 0.09 0.11 0.11 1.00 0.10
10 0.21 0.50 0.50 0.32 0.16 0.47 0.96 0.20 0.20 0.19 1.00 0.16
11 0.18 0.23 0.17 0.15 0.16 0.29 0.58 0.11 0.11 0.11 0.80 0.12
12 0.19 0.50 0.30 0.29 0.14 0.36 0.82 0.15 0.07 0.10 0.80 0.11
A. Lockamy III and K. McCormack
13 0.18 0.37 0.27 0.16 0.16 0.23 0.62 0.08 0.12 0.10 1.00 0.09
14 0.20 0.50 0.50 0.31 0.16 0.50 0.96 0.20 0.20 0.18 1.00 0.11
15 0.17 0.35 0.33 0.14 0.16 0.22 0.60 0.10 0.12 0.13 1.00 0.12
Table 2. Supplier risk profiles.
Network risk Operational risk External risk Probability of

Supplier probability probability probability revenue impact
1 0.34 0.47 0.43 0.41

2 0.19 0.23 0.38 0.27
3 0.33 0.46 0.43 0.40
4 0.21 0.23 0.39 0.28
5 0.23 0.23 0.41 0.29
6 0.24 0.30 0.43 0.32
7 0.22 0.27 0.41 0.30
8 0.22 0.27 0.41 0.30
9 0.22 0.28 0.40 0.30
10 0.34 0.46 0.45 0.41
11 0.18 0.27 0.34 0.26
12 0.28 0.35 0.33 0.32
13 0.23 0.27 0.39 0.30

14 0.33 0.47 0.43 0.41
15 0.23 0.26 0.41 0.30
Table 3. Risk profile sensitivity analysis for Supplier 1.
Network risk Operational risk External risk Probability of

probability probability probability revenue impact
*0.34 *0.47 *0.43 *0.41

1.00 0.47 0.43 0.63
0.34 1.00 0.43 0.59
0.34 0.47 1.00 0.60
1.00 1.00 0.43 0.81
1.00 0.47 1.00 0.83
0.34 1.00 1.00 0.78
Note: *base case.
between a supplier’s base case and worst-case combination risk profile is 67% for Supplier
11 ($11.92 million versus $35.75 million). However, the average percentage increase in
value-at-risk dollars between these scenarios is 60% for all suppliers. Along with Supplier
11, Suppliers 2, 4, 5, and 7 exhibit the largest increases in value-at-risk dollars between
their base case and worst-case risks combination (66%, 65%, 64%, and 64%,
respectively). The smallest percentage increase in this area is 50%, as exhibited by the
risk profiles associated with Suppliers 10 and 14. It is interesting to note that the risk
profile of Supplier 10 resulted in two worst-case risk combinations: network risk-
operational risk and network risk-external risk. These risk combinations both yielded a
0.82 probability of revenue impact value. Finally, the most prevalent worst-case
combination for the 15 suppliers is the simultaneous occurrence of network and
operational risk events. This combination resulted in the highest probability of revenue
impact values for 11 suppliers. The network risk-external risk combination provided the
highest probability of revenue impact values for five suppliers. The combination of
simultaneous operational and external risk events failed to yield a worst-case combination
for any supplier.
Table 4. Risk profile and value at risk sensitivity analysis for all suppliers.
Annual Monthly Value-at-risk

Network Operational External Probability revenue revenue (probability monthly
risk risk risk of revenue impact impact revenue
Supplier probability probability probability impact (millions) (millions) impact)
1 *0.34 *0.47 *0.43 0.41 $225 $18.75 $7,687,500

1 0.47 1 0.83 $225 $18.75 $15,562,500
2 *0.19 *0.23 *0.38 0.27 $375 $31.25 $8,437,500
1 1 0.38 0.79 $375 $31.25 $24,687,500
3 *0.33 *0.46 *0.43 0.40 $2610 $217.5 $87,000,000
1 0.46 1 0.82 $2610 $217.5 $178,350,000
4 *0.21 *0.23 *0.39 0.28 $2165 $180.42 $50,516,667
1 1 0.39 0.80 $2165 $180.42 $144,333,333
5 *0.23 *0.23 *0.41 0.29 $900 $75.00 $21,750,000
1 1 0.41 0.81 $900 $75.00 $60,750,000
6 *0.24 *0.30 *0.43 0.32 $5580 $465.00 $148,800,000

1 1 0.43 0.81 $5580 $465.00 $376,650,000
7 *0.23 *0.26 *0.40 0.29 $1075 $89.58 $25,979,167
1 1 0.40 0.80 $1075 $89.58 $71,666,667
8 *0.22 *0.27 *0.41 0.30 $210 $17.50 $5,250,000
1 1 0.41 0.81 $210 $17.50 $14,175,000
9 *0.22 *0.28 *0.40 0.30 $3490 $290.83 $87,250,000
1 1 0.40 0.80 $3490 $290.83 $232,666,667
10 *0.34 *0.46 *0.45 0.41 $1635 $136.25 $55,862,500
1 1 0.45 0.82 $1635 $136.25 $111,725,000
1 0.46 1 0.82 $1635 $136.25 $111,725,000
11 *0.18 *0.27 *0.34 0.26 $550 $45.83 $11,916,667
1 1 0.34 0.78 $550 $45.83 $35,750,000
12 *0.28 *0.35 *0.33 0.32 $550 $45.83 $14,666,667
1 0.35 1 0.79 $550 $45.83 $36,208,333
13 *0.23 *0.27 *0.39 0.30 $1135 $94.58 $28,375,000
1 1 0.39 0.80 $1135 $94.58 $75,666,667
14 *0.33 *0.47 *0.43 0.41 $250 $20.83 $8,541,667
1 0.47 1 0.82 $250 $20.83 $17,083,333
15 *0.23 *0.26 *0.41 0.30 $85 $7.08 $2,125,000
1 1 0.41 0.81 $85 $7.08 $5,737,500
Note: *base case.
5. Managerial actions
There are several items which should be examined by the company for possible managerial
actions based upon the results of this study. Given the potential impact that Supplier 6
could have on the company’s revenue stream based upon its risk profile, it is imperative
that the company take proactive measures to reduce its value-at-risk exposure with this
supplier. For example, the company might engage in cooperative improvement projects
with the supplier in an effort to reduce network and operational risks. On the contrary, the
company may choose to discontinue its outsourcing relationship with this supplier, or
apportion more of its business to one of the other 14 automotive casting suppliers
exhibiting a less risky profile. In any event, the company should make reducing its revenue
exposure to Supplier 6 a major priority.
An examination of Table 4 shows that one-third of the company’s suppliers have
the potential to increase their value-at-risk percentages by at least 64% through the
occurrence of risk events resulting in worst-case combination scenarios. The company

should also re-evaluate its outsourcing relationship with these suppliers. Finally, with a
potential average percentage increase in value-at-risk dollars of 60% for all suppliers, it
may be prudent for the company to conduct a ‘make versus buy’ analysis to examine the
possibility of ‘insourcing’ this commodity. Given the magnitude and potential volatility of
these dollars due to the suppliers’ risk profiles, it may be more economical (and less risky)
to furnish the castings via internal sources.
6. Conclusions and implications

We conclude that this study illustrates a methodology for analysing risks in supply
networks which can be used to facilitate outsourcing decisions. Risk profiles can be
developed using Bayesian networks for suppliers furnishing common raw materials or
components which can be examined to analyse current and future outsourcing relation-
ships. The profiles can also be used to determine the risk exposure of a company’s revenue
for its supplier base. Additionally, we conclude that the methodology could also be used to
analyse risks associated with potential suppliers who are under consideration as part of a
company’s outsourcing strategy. Finally, we conclude that the methodology presented in
this study could also serve as a tool for examining the viability of insourcing based upon
an assessment of the aggregate risk profile of the supply network for the commodity.
6.1 Limitations
This study provided an examination of risk profiles associated with casting suppliers in the
US automotive industry. Therefore, the results could be industry-specific in nature. In
addition, the study examined only 15 suppliers in the US automotive industry, thus
limiting the generalisability of outsourcing risks in this sector. A limitation to the use of the
methodology presented in this study is the ability to access the necessary data needed to
construct the Bayesian networks. Depending on the established relationship, some
suppliers may be reluctant to share risk profile data with their customers. However, the
most important potential limitation to the use of this methodology to assess risks in supply
networks is the supplier’s ability to provide accurate information regarding network,
operational, and external risks as reflected in the 12 risk events outlined in Appendix 2.
Suppliers must be willing to periodically update this information in order to construct
a risk profile that is valid and reliable.
6.2 Future research

Risk profiles for suppliers and supply networks in other industries should be examined
using the methodology illustrated in this study to determine if industry dynamics
significantly influence supply chain risks. In addition, future researchers may choose to
solely focus on the impact of network, operational, or external risks on supply networks.
For example, what would be the value-at-risk for a company if it were possible to totally
eliminate network risk? Finally, future researchers may examine the simultaneous
occurrence of operational and external risk events to see if there are supply networks
and/or industries where this combination results in the worst-case combination for
a company based on value-at-risk dollars.
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Appendix 1. Bayesian network example

Suppose that the state of the US economy is classified into three categories: recession (S1),
stability (S2), and prosperity (S3). The business research department of a large firm is responsible for
developing forecasts regarding the economic condition for the following year. The department
makes two types of forecasts: optimistic (A) and pessimistic (B). Suppose further that based upon
years of prior data, the proportion of times that optimistic and pessimistic forecasts were made in the
preceding years are as follows:
PðAjS1 Þ ¼ 0:1, PðAjS2 Þ ¼ 0:5, PðAjS3 Þ ¼ 0:8;
PðBjS1 Þ ¼ 0:9, PðBjS2 Þ ¼ 0:5, PðBjS3 Þ ¼ 0:2:
It is also assumed that stability is twice as likely to appear as either recession or prosperity. The
firm is interested in analysing the following issues:
(1) If the forecast for the next year is optimistic, what is the probability that the economy will be
prosperous? (i.e., P(S3|A).)
(2) If the forecast for the next year is pessimistic, what is the probability that the economy will
be in a recession? (i.e., P(S1|B).)

From the information provided in this example, the following Bayesian network can be
constructed:
S1 S2 S3
A B
Bayesian networks can be used to perform inductive reasoning (diagnosing a cause given an
effect) and deductive reasoning (predicting an effect given a cause).
A conditional probability table also containing the a priori probabilities for each state of the
economy based on the provided data is given in Table A1.
A joint probability table is also developed by multiplying the a priori probabilities by the
corresponding conditional probabilities for a given state of the economy, which is illustrated in
Table A2.
Using Bayesian analysis, the following answers are obtained regarding the aforementioned issues:
PðS3 \ AÞ 0:200
ð1Þ PðS3 jAÞ ¼ ¼ ¼ 0:42;
PðAÞ 0:475
PðS1 \ BÞ 0:225
ð2Þ PðS1 jBÞ ¼ ¼ ¼ 0:43:
PðBÞ 0:525
Table A1. Conditional probability table.
State of the Optimistic Pessimistic

A priori probability economy forecast (A) forecast (B)
P(S1) ¼ 0.25 S1 0.1 0.9

P(S2) ¼ 0.50 S2 0.5 0.5
P(S3) ¼ 0.25 S3 0.8 0.2
Table A2. Joint probability table.
State of the economy Optimistic forecast (A) Pessimistic forecast (B)
S1 PðS1 \ AÞ ¼ 0.025 PðS1 \ BÞ ¼ 0.225

S2 PðS2 \ AÞ ¼ 0.250 PðS2 \ BÞ ¼ 0.250
S3 PðS3 \ AÞ ¼ 0.200 PðS3 \ BÞ ¼ 0.050
Total P(A) ¼ 0.475 P(B) ¼ 0.525
Thus, the probability that next year’s economy will be prosperous if the forecast is optimistic is
42%, while the probability that next year’s economy will be in a recession if the forecast is pessimistic
is 43%.
Appendix 2. Risk assessment measures
Behaviour Relationship Supplier revenue from industry segment

Influence of revenue from company
Supplier/company alignment
Supplier/company information sharing
Performance Accreditation
Engineering support
Capacity utilisation
Capacity change
Delivery flexibility
Manufacturing employees
Service promptness
MRR
Audit date
Audit score
On-time delivery
Human resources Employee turnover
Senior staff turnover
Union issues
Pay position
Structure Supply chain disruption Market power
Tier 2 information sharing
Tier 2 performance monitoring
Disruption probability
Risk management system
Material sourcing base
Financial health Market growth
Financial risk indicators
Environmental Market dynamics
Merger and acquisition
Regulatory
Disaster
Transportation
Network Supplier’s customers
Supplier customer relationships
Alignment
Supplier’s supplier
Supplier vendor relationships
Vendor concentration
Code of conduct
Appendix 3. Network, operational and external risk measures
Network risks Misalignment of interest Influence of revenue from company

Supplier revenue from commodity category
Supplier/company alignment
Regulatory
Supplier financial stress Customer portfolio
Business health indicators
Segment portfolio
Market growth
Financial data sharing
Supplier leadership change Company ownership change likelihood
Senior staff turnover
Tier 2 stoppage Process change likelihood
Miscommunication between tiers
Material change/obsolesce likelihood
Risk management system
Material sourcing base
Market power
Regulatory
Regulatory change risk likelihood
Inventory status sharing
Tier 2 supplier information sharing
Process/material change notification
Supplier network misalignment Supplier customer alignment
Vendor concentration
Operational risks Quality problem Process change likelihood
MRR (defects)
Audit date
Audit score
Tier 2 performance monitoring
Quality problems likelihood
Accreditation
Material change/obsolesce likelihood
Process/material change notification
Delivery problem Performance data sharing
On-time delivery
Capacity utilisation
Tier 2 information sharing
Delivery flexibility
Capacity shortage likelihood
Capacity change
Inventory status sharing
Order fulfilment information sharing
Production schedule sharing
Service problem Engineering support
Service promptness
Employee turnover
Human resource issues likelihood
New technology opportunity sharing
External Risks Supplier HR problem Union issues
Employee turnover
Pay position
Supplier locked Accreditation information sharing
EPA and FDA report sharing
Regulatory
Accreditation
Merger/divestiture Market dynamics
Disasters Supplier is providing proof of insurance
Disaster
Transportation
Appendix 4. Risk profile for Supplier 1

Given the risk event relationships exhibited in the supplier Bayesian network illustrated in Figure 2
along with the a priori probabilities for risk event variables contained in Table 1, the following
probability computations regarding network risks, operational risks, external risks, and revenue
impact for Supplier 1 are provided:
P
ðprobability of network risk eventÞ ðprobability of event occurrenceÞ
Pðnetwork risksÞ ¼ P
ðprobability of event occurrenceÞ
½ð0:20Þ ð1Þ þ ½ð0:50Þ ð1Þ þ ½ð0:50Þ ð1Þ þ ½ð0:31Þ ð1Þ þ ½ð0:20Þ ð1Þ
¼
1þ1þ1þ1þ1
1:71
¼
5
¼ 0:034;
P
ðprobability of operational risk eventÞ ðprobability of event occurrenceÞ

Pðoperational risksÞ ¼ P
½ð0:46Þ ð1Þ þ ½ð1:00Þ ð1Þ þ ½ð0:20Þ ð1Þ þ ½ð0:20Þ ð1Þ
¼
1þ1þ1þ1
1:86
¼
4
¼ 0:47;
P
ðprobability of external risk eventÞ ðprobability of event occurrenceÞ
Pðexternal risksÞ ¼ P
½ð0:18 ð1Þ þ ½ð1:00Þ ð1Þ þ ½ð0:11Þ ð1Þ
¼
1þ1þ1
1:29
¼
3
¼ 0:43;
Pðrevenue impactÞ
P
½PðNRÞ PðoccurrenceÞ þ ½PðORÞ PðoccurrenceÞ þ ½PðERÞ PðoccurrenceÞ
¼ P
ð probability of risk occurrenceÞ
½ð0:34 ð1Þ þ ½ð0:47Þ ð1Þ þ ½ð0:43Þ ð1Þ
¼
1þ1þ1
1:24
¼
3
¼ 0:41:

Analysing Risks in Supply Networks To Facilitate Outsourcing Decisions

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Analysing risks in supply networks to facilitate outsourcing decisions

In an effort to achieve a competitive advantage via cost reductions and

outsourcing as a major component of their supply chain strategies. However,

*Corresponding author. Email: aalockam@samford.edu

ISSN 0020–7543 print/ISSN 1366–588X online

2. Supply chain management

2.2 Supply chain risks

(Wagner and Bode 2006).

3.1 Bayesian networks

In recent years, Bayesian networks have evolved as a powerful tool to analyse

3.2 Assessment model

The customer’s reputation with

Figure 1. Risk assessment model.

3.3 Sample and data collection

Network Operational External

4.1 Sensitivity analysis

Table 1. A priori probabilities for risk event variables.

Supplier Supplier Supplier

Table 2. Supplier risk profiles.

Network risk Operational risk External risk Probability of

1 0.34 0.47 0.43 0.41

13 0.23 0.27 0.39 0.30

Table 3. Risk profile sensitivity analysis for Supplier 1.

Network risk Operational risk External risk Probability of

*0.34 *0.47 *0.43 *0.41

Note: *base case.

Annual Monthly Value-at-risk

1 *0.34 *0.47 *0.43 0.41 $225 $18.75 $7,687,500

6 *0.24 *0.30 *0.43 0.32 $5580 $465.00 $148,800,000

Note: *base case.

occurrence of risk events resulting in worst-case combination scenarios. The company

6. Conclusions and implications

6.2 Future research

Appendix 1. Bayesian network example

be in a recession? (i.e., P(S1|B).)

Table A1. Conditional probability table.

State of the Optimistic Pessimistic

P(S1) ¼ 0.25 S1 0.1 0.9

Table A2. Joint probability table.

State of the economy Optimistic forecast (A) Pessimistic forecast (B)

S1 PðS1 \ AÞ ¼ 0.025 PðS1 \ BÞ ¼ 0.225

Appendix 2. Risk assessment measures

Behaviour Relationship Supplier revenue from industry segment

Appendix 3. Network, operational and external risk measures

Network risks Misalignment of interest Influence of revenue from company

Appendix 4. Risk profile for Supplier 1

ðprobability of operational risk eventÞ ðprobability of event occurrenceÞ

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0.34 0.47 0.43 0.41

1 0.34 0.47 *0.43 0.41 $225 $18.75 $7,687,500

6 0.24 0.30 *0.43 0.32 $5580 $465.00 $148,800,000